The Indian market (Nifty Fut/India-50) is currently trading around 10350 in the mid-session Thursday, slumped by almost -0.40% on the concern of RBI autonomy despite positive global cues, an upbeat manufacturing PMI, lower USDINR, and lower oil. The market was also boosted by another report that Iran may accept Rupee payment mechanism for its oil export to India to avoid Trump/US sanction. The market is also supported by India’s jump in “ease of doing business”.

But the market recovered to some extent on better than expected October Manufacturing PMI, which rose to 53.1 from prior 52.2, higher than the consensus of 51.9. The October Mfg PMI is the highest since June’18, boosted by increasing new orders (ahead of festival season), although export orders slumped.

As per Markit:

“Manufacturing continued to make up for ground lost in August, with a robust and accelerated rise in new orders boosting production growth in October and the consumer, intermediate and investment goods output all increased at stronger rates. The trend for employment was particularly encouraging, with job creation at a ten-month high. Firms sought to increase their competitive edge, with marketing activity and investment in research and development, which meant the business sentiment remained positive. However, goods producers see challenges and uncertainties ahead, which in turn translated into the weakest degree of optimism seen in 20 months”.

The Indian market recovered from a deep slump on Wednesday as the government dials back its RBI rhetoric, seeing the adverse market reaction. Nifty recovered from 10105 and jumped to a high of 10396 as the government acknowledged explicitly that the central bank’s autonomy, within the framework of the RBI Act, is an “essential and accepted governance requirement”. Eventually, Nifty slumped almost 11% in October and September primarily of the NBFC/NFC default/liquidity crisis issues, higher USDINR, and surging oil.

On Wednesday, five days after RBI Deputy Governor Viral Acharya’s speech went “viral”, the Finance Ministry broke its silence to acknowledge the importance of the central bank’s independence.

On Friday, Acharya said that undermining the central bank’s independence could be “potentially catastrophic”. The controversy escalated on reports that the government had invoked Section 7 of the RBI Act to issue directions on various issue, including reviewing Prompt Corrective Action (PCA), NBFC funding and transfer of RBI surplus to the government.

The RBI has been pushing for more powers to clean up the banking system. In his speech on Friday, Acharya had said the central bank’s autonomy would be strengthened by having regulatory control over state-run banks. It is also believed that the RBI is not happy with government-appointed directors pressing for easier credit access to SMEs.

The government has used a rare Section-7, which is essentially a weapon of the government to cease all autonomy of the RBI and the RBI is then bound to act as per the government directive. On Wednesday, a senior government official said: “Yes, the government has used it (Section 7), as there is a need for accountability. The RBI board will meet on November 19; it is expected that the government nominees will press for a concrete resolution on contentious issues”.

Meanwhile, the Indian Finance Minister Jaitley, responding to repeated questions on the RBI controversy, said that communications and layers of consultations between the government and the RBI have never been disclosed. However, decisions are made public, he said, while categorically ruling out a situation of “financial emergency”. The Indian FM said on Wednesday: “Only the most ignorant will say the world’s fastest-growing economy is in a state of financial emergency”.

Earlier Wednesday, a Finance Ministry statement said: “Both the government and the RBI, in their functioning, have to be guided by public interest and the requirements of the Indian economy. Extensive consultations on several issues take place between the government and the RBI from time to time. The government had never made public the subject matter of the consultations. Only the final decisions taken are communicated. The government, through these consultations, places its assessment on issues and suggests possible solutions. The government will continue to do so”.

In brief, as the “war of words” between the government and RBI broke out, there are reports that RBI governor and the entire MPC may resign on the issue of political (government) interference in RBI’s autonomy. This is an unprecedented situation in India, where the government is also eyeing the RBI surplus of around Rs.3T to fund fiscal deficit.

Apart from NBFC/HFC funding (bailout), the government is also pressurizing the RBI to ramp up MSME funding (ahead of the election) and asked the central bank to let some PSU banks out of PCA, so that they could resume lending. The government is apprehending that India’s growth could slow down as NBFC almost stops lending due to “lack of liquidity”. The government is also planning to provide the Rs.43B bailout fund (recaps) to various PSU banks sooner rather than later.

The RBI said it’s not a liquidity issue but it’s an NPA/NPL problem with the NBFC/HFC. Both the government and RBI may be right as the yield of the commercial bond market (CP) is now abnormally high and there are growing stressed assets in the NBFC/HFC sector involving business as-well-as personal loan accounts.

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